When it comes to the topic of taxes, most of us know we’re paying them, but we aren’t sure about much else.
If that sounds like you, you’re not alone. Taxes are one of the most frequently misunderstood and stressed topics of adulthood.
We know that two things are certain: death and taxes. But we don’t always know where our taxes are going or how much we’re paying for them.
Check out your pay stub, for instance. You know how much you bring home, but it can be an eye-opening shocker when you really look at the money that goes toward taxes.
So what is all that money going to, and why do we pay taxes anyway? Here are a few things to keep in mind about how taxes work, and how you can use your knowledge to save money.
1. Payroll Taxes
Every working citizen pays payroll taxes, even if they’re self-employed. This chunk of your income is submitted federally, covering government expenses.
Most payroll taxes are used to fund programs like Medicare and Social Security. You’ll see Social Security taxes on your pay stub under the category of FICA (Federal Insurance Contributions Act).
Employers and employees have to pay these taxes regardless of their wages up to a certain cap.
But the distribution isn’t equal. Those in the low- and moderate-income categories pay a slightly higher percentage of their wages in taxes than high-income earners pay.
On the other hand, when you do need to use your Social Security and Medicare, that distribution flips. Low- and moderate-income people receive a higher rate of their previous earnings through Social Security. And Medicare premiums are more expensive for those in the higher income brackets.
2. Services Are Taxed Differently
The next time you go to a movie or an amusement park, look closely at your receipt. You’ll probably see an extra charge there called an entertainment tax.
This varies by location. Every state divides business services into six basic categories and the type of tax for each section changes.
The state taxes an entity pays depend partly on its type of service. The business then recoups these costs through its customer.
You’re charged sales tax if you’re buying tangible personal property (TPP). Now, some states have begun charging taxes on businesses that provide services on personal property. So, if you hire someone to fix your sink or repair your car, you might see sales tax on your final bill.
Businesses that provide a service to another company or business, such as a credit reporting agency or a call center, are taxed. Their clients see this tax on their invoices.
Personal services, such as a pet groomer or an unlicensed massage therapist, pay taxes. And if you’re headed to a ball game or another entertaining event, some states still tax those, too.
The sales tax rate varies by state, but it also changes depending on the product or service.
One of the most glaring examples of this is cannabis. If you have a medical marijuana card and get your product from a dispensary, you’ll pay a small excise tax on the sale. But where recreational cannabis is legal, the excise sales tax is much higher.
If you think that’s high, though, you won’t want to look at your fuel bill. States like California charge an excise tax of over half a dollar per gallon, plus the federal tax, state sales tax, and special program fees.
Over one dollar goes straight to taxes and fees out of the “amount per gallon” that you see. This little nugget of knowledge is helpful if you live close to a state with a lower tax rate. Driving a few extra miles could save you hundreds of dollars on fuel every year.
3. Your Online Income is Still Taxable
With the freelancing industry booming, the IRS wants their cut. They’ve developed strict guidelines for online sales.
As a business owner or freelancer, you’re required to collect sales tax from your online customers if you have a physical presence in a state. That said, you don’t “have” to collect the tax, but you will be charged for it on your income tax form.
And if you don’t have a physical presence, you still have to pay taxes on your income. If you make more than $600 from one client or platform, like Etsy or PayPal, you’ll get a 1099 from the company. Since the IRS gets the same form, you’ll need to account for that money on your taxes.
Dealing with any government entity can be confusing, but when it’s the IRS, and you’re paying taxes, it’s a whole new ballgame. However, these three important pieces of tax knowledge might just save you some money in the future.